BIBLIOGRAPHY ON PERFORMANCE OF PRIVATE EQUITY INVESTMENT FUNDS

2015

Demaria [2015]: Cyril Demaria, “Fee Levels, Performance and Alignment of Interests in Private Equity,” Journal of Alternative Investments 17(4):95-135, Spring 2015.

On a net basis, more than 20 years of U.S. PE do not deliver any significant out- or under-performance. … On a gross basis, there is a systematic PE outperformance as compared with the total market index. Consequently, fees capture the alpha of GPs.

2014

Ang, Brandt & Denison [2014]: Andrew Ang, Michael W. Brandt, and David F. Denison, “Review of the Active Management of the Norwegian Government Pension Fund Global,” January 2014.

Phalippou (2010), in his report to the Ministry of Finance on private equity observed that “An investor without special selection skills…is unlikely to earn alpha from its private equity investment in the long run.” We agree with this assessment and also observe that the selection process for many investors is superficial at best and heavily reliant on the published performance numbers (with the inherent flaws noted by Phalippou) furnished by private equity managers.

Ang et al. [2014]: Andrew Ang, Bingxu Chen, William N. Goetzmann, and Ludovic Phalippou, “Estimating Private Equity Returns from Limited Partner Cash Flows,” June 2014.

Our estimate suggests that private equity is, to a first approximation, a levered investment in small and mid-cap equities. … We find that in the first part of our sample period [1992-2008] the private equity premium contributed positively to returns and in the second period it detracted from returns. … Over the sample, the cumulated private equity premium is zero, so private equity has had an alpha of zero.

Arcot et al. [2014]: Sridhar Arcot, Zsuzdanna Fluck, José-Miguel Gaspar, and Ulrich Hege, “Fund Managers Under Pressure: Rationale and Determinants of Secondary Buyouts,” Journal of Financial Economics (forthcoming), March 2014.

Our analysis provides strong evidence that pressured funds are more likely to invest in secondary buyouts, pay higher valuation multiples, use lower leverage and rely less on syndicate finance. … On a subsample of completed deals we report that funds with higher average buy pressure have lower IRR and return multiple over the life of the fund. Our findings provide strong support for the prediction…that PE funds with substantial unspent capital late in their investment period are more likely to make negative NPV investments.

Beath, Flynn & MacIntosh [2014]: Alex Beath, Chris Flynn, and Jody MacIntosh, “How Implementation Style and Costs Affect Private Equity Performance,” Rotman International Journal of Pension Management 7(1):50-54, Spring 2014.

Over the 17-year period ending 2012, the average annualized compound net value added from (private equity investment through) internal direct investment and co-investment was 3.52%, whereas net value added was 0.28% for (private equity investment through) limited partnerships and -1.63% per year for (private equity investment through) fund-of-funds limited partnerships. … Our findings confirm those of other CEM research indicating that the highest-cost implementation styles have the worst net returns.

The cost of private equity limited partnerships is frequently reported to be less than 0.70% by funds’ financial statements, whereas Dutch funds that are beginning to collect and report all private asset costs are reporting a median of 3.03%: 0.12% internal monitoring costs + 1.66% management fees + 1.10% carry or performance fees + 0.15% transaction fees.

Braun & Schmidt [2014]: Reiner Braun and Maximilian Schmidt, “The Limited Partnership Model in Private Equity: Deal Returns over a Fund’s Life,” January 2014.

Considering intra-fund performance variations in limited partnerships, we find that deals exited before the final closing of a follow-on fund significantly outperform deals exited afterwards. This pattern strongly indicates a moral hazard issue in the GP-LP relationship that incentivizes fund managers to actively game their portfolio. … We find intra-fund performance differences between before and after the closing of a follow-on fund to be particularly pronounced in recent years, since 1999.

Brown, Gredil & Kaplan [2014]: Gregory W. Brown, Oleg R. Gredil, and Steven N. Kaplan, “Do Private Equity Funds Game Returns?,” March 2014.

We investigate whether there is evidence that private equity firms manipulate their NAV reports to investors. We find that some reported returns are abnormally high during periods when firms are likely to be marketing their new funds to prospective investors. … However, this fund timing pattern appears limited to the subset of underperforming funds. Moreover, it does not go unnoticed by the investors as firms reporting run-ups and reversals typically fail to raise a follow-on fund. … LPs appear to punish GPs for what looks like dishonest interim reporting in the midst of the GPs’ next fundraising by not providing capital to subsequent funds. Correspondingly, top performing GPs try to safeguard their long-term reputation from a ‘bad luck’ even in later stages of fund lives by reporting conservative NAVs, particularly when it does not jeopardize their high relative performance rank. For underperforming GPs, these long-term reputational concerns appear to be dominated by a short-term survival requirement to raise a next fund. Therefore, they are incentivized to boost to-date results to the extent the gap is not too large.

Buchner & Stucke [2014]: Axel Buchner and Rϋdiger Stucke, “The Systematic Risk of Private Equity,” March 2014.

Our estimations show that the exposure to systematic risk is notably higher than previously estimated and widely assumed, with beta coefficients ranging from 2.5 to 3.1. While carried interest provisions reduce the exposure to systematic risk, we find that management fees effectively offset this effect. … As expected, both management fees and carried interests have a negative effect on the abnormal returns delivered to institutional investors. For buyout funds, annual alphas are slightly negative but statistically insignificantly different from zero. Net alphas of venture capital funds remain positive and range from 2% to 5%.

Chakraborty & Ewens [2014]: Indraneel Chakraborty and Michael Ewens, “When Reputation is Not Enough: Portfolio Manipulation and Fund-Raising in Venture Capital,” April 2014.

It is often said that a venture capitalist has two jobs: investing in entrepreneurial firms and raising their next fund. That next fund provides a steady stream of performance-insensitive management fees for at least ten years. Performance evaluation by the capital providers to limited partners is thus an area ripe for manipulation.

We find that reputation concerns are unable to eliminate agency problems between VCs and their investors. We find that many portfolio characteristics of VC funds respond to fund-raising activities and outcomes. VCs delay signaling negative information about their quality until after raising new funds. Once a VC raises a new fund, they write off past investments more often and invest using different securities. The entrepreneurial firms that receive capital are relatively worse than those financed prior to the fund closing: they have both lower valuation and lower probability of successful exit. The average difference in returns for firms in which VCs invest after raising new funds is approximately 11% lower compared to firms financed by VCs before raising new funds.

Degeorge, Martin & Phalippou [2014]: Francois Degeorge, Jens Martin, and Ludovic Phalippou, “On Secondary Buyouts,” October 2014.

General partners with unspent capital at the end of a fund’s investment period have an incentive to do deals that are not in the interest of their limited partners. We argue that secondary buyouts are a key channel for GPs wishing to burn capital. Consistent with this agency hypothesis, we find that SBOs made late in a fund’s investment period underperform similar buyouts. Late SBO underperformance is magnified when funds have more unspent capital. … Late SBOs are value-destroying for the limited partners invested in the buying funds. After a fund invests in late SBOs, investors appear to shun the follow-on fund.

Harris, Jenkinson & Kaplan [2014]: Robert S. Harris, Tim Jenkinson, and Steven N. Kaplan, “Private Equity Performance: What Do We Know?,” Journal of Finance 69(5):1851-1882, July 2014.

First, it seems likely that buyout funds have outperformed public markets, particularly the S&P 500, net of fees and carried interest, in the 1980s, 1990s, and 2000s. Our estimates imply that each dollar invested in the average fund returned at least 20% more than a dollar invested in the S&P 500. This works out to an outperformance of at least 3% per year. … Second, VC funds outperformed public markets substantially until the late 1990s, but have underperformed since. … Since 2000, the average VC fund has underperformed public markets by about 5% over the life of the fund. … Third, vintage year performance for buyout and VC funds decreases with the amount of aggregate capital committed to the relevant asset class, particularly for absolute performance, but also for performance relative to public markets. … Finally, although it is natural to benchmark private equity returns against public markets, investing in a portfolio of private equity funds across vintage years inevitably involves uncertainties and potential costs related to the long-term commitment of capital, uncertainty of cash flows and the liquidity of holdings that differ from those in public markets. While the average out-performance of private equity we find is large, further research is required to calibrate the extent of the premia investors required to bear these risks.

Harris et al. [2014]: Robert S. Harris, Tim Jenkinson, Steven N. Kaplan, and Ruediger Stucke, “Performance Persistence in Private Equity: How Has It Changed?” Private Equity Research Consortium, March 2014.

The conventional wisdom for investors in private equity funds is to invest in partnerships that have performed well in the past. This is based on the belief that performance in private equity persists across funds of the same partnership.

Post-2000, we find that persistence of buyout fund performance has fallen considerably. When funds are sorted by the quartile of performance of their previous funds, performance of the current fund is statistically indistinguishable regardless of quartile. At the same time, however, the returns to buyout funds in all previous performance quartiles, including the bottom, have exceeded those of public markets as measured by the S&P 500. … For venture capital, we find that performance remains as persistent after 2000 as before. Partnerships whose previous VC funds fell below the median for their vintage year subsequently tend to be below median and have returns below those of public markets (S&P 500). Partnerships in the top two VC quartiles tend to stay above the median and their returns exceed those of the public markets.

Korteweg & Sorensen [2014]: Arthur G. Korteweg and Morten Sorensen, “Skill and Luck in Private Equity Performance,” Rock Center for Corporate Governance Working Paper 179, April 2014.

We decompose private equity performance into skill and luck. When performance is noisy, top-quartile performance does not necessarily imply top-quartile skills. … Investable persistence reflects the ability of LPs to identify skilled PE firms from their past performance. We find that past performance is noisy, with a poor signal-to-noise ratio, making it difficult to identify skilld PE firms, particularly for VC firms. An LP needs to observe an excessive number of past funds to identify those with top-quartile skills with reasonable certainty.

Phalippou [2014]: Ludovic Phalippou, “Performance of Buyout Funds Revisited?,” Review of Finance 18(1):189-218, January 2014.

This study shows that buyout funds mainly invest in small and value companies. Adjusting for the size premium brings the average buyout fund return in line with small cap indices and with the oldest small-cap passive mutual fund. If the benchmark is changed to small and value indices, and is levered up, the average buyout fund underperforms by -3.1% per annum.

Sensoy, Wang & Weisbach [2014]: Berk A. Sensoy, Yingdi Wang, and Michael S. Weisbach, “Limited Partner Performance and the Maturing of the Private Equity Industry,” Journal of Financial Economics 112(3):320-343, June 2014.

We find that the superior performance of endowment investors in the 1991-1998 period, documented in prior literature, is mostly due to their greater access to the top-performing venture capital partnerships. In the subsequent 1999-2006 period, endowments no longer outperform, and neither have greater access to funds that are likely to restrict access nor make better investment selections than other types of institutional investors.

Sorensen, Wang & Yang [2014]: Morten Sorensen, Neng Wang, and Jinqiang Yang, “Valuing Private Equity,” Review of Financial Studies 27(7):1977-2021, July 2014.

The performance of PE funds is typically evaluated in terms of their internal rate of return (IRR) and public-market equivalent (PME). Our model gives break-even values of these two performance measures. … This break-even alpha can be interpreted as the LP’s additional cost of capital, in addition to the standard CAPM-implied cost of capital, due to the costs of illiquidity and the GP’s compensation. Quantitatively, we find that the cost of illiquidity is substantial. … We find that the break-even values implied by our model are reasonably close to the actual reported performance for buyout funds, suggesting that LPs in these funds may just break even, on average.

Welch [2014]: Kyle Welch, “Private Equity’s Diversification Illusion: Economic Comovement and Fair Value Reporting,” March 2014.

I show that returns provided by private equity firms understate the economic comovement between private equity and market returns, creating a diversification illusion. I find that private equity funds that adopted redefined fair value accounting reported returns with increased market betas and correlations. Additionally, I find that abnormal returns to private equity firms disappear after adopting fair value standards.

2013

Axelson et al. [2013]: Ulf Axelson, Tim Jenkinson, Per Strömberg, and Michael S. Weisbach, “Borrow Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts,” Journal of Finance 68(6):2223-2267, December 2013.

Private equity practitioners often state that they use as much leverage as they can. This claim appears to be consistent with the data. … We document that buyout leverage is driven almost entirely by time-series variation related to debt market conditions. … The main factors that affect the capital structure of buyouts are the price and availability of debt: When credit is abundant and cheap, buyouts become more leveraged. … These results are consistent with the view that lax credit conditions make it easier for sponsors to raise money through leverage, which in turn leads them to overpay for deals.

To summarize, the evidence that fund-level returns are negatively related to transaction-level leverage suggests that private equity sponsors may be acting more in their own (carried!) interest than their investors’ when they impose highly leveraged capital structures on their portfolio companies. … Our data indicate that the prices that private equity funds seem to be willing to pay for highly levered deals are not only high, but possibly excessive.

Braun, Jenkinson & Stoff [2013]: Reiner Braun, Tim Jenkinson, and Ingo Stoff, “How Persistent is Private Equity Performance? Evidence from Deal-Level Data,” August 2013.

First, our analysis confirms the findings of Kaplan & Schoar [2005], who found performance persistence across funds raised until the late 1990s. … When we extend the sample with deals that exited until 2010 we find that absolute performance persistence has disappeared in recent years. ... Second, … in line with the results obtained for absolute performance persistence, we find that relative performance persistence is apparent only until the late 1990s, and has essentially disappeared for funds investing in the second half of the sample. Third, … across GPs, the probability that a GP will repeat top quartile performance is now no better than random. For investors this research has clear, but uncomfortable, implications. The often-heard mantra of sticking with top-performing managers is no longer a recipe for success.

Da Rin, Hellmann & Puri [2013]: Marco Da Rin, Thomas Hellmann, and Manju Puri, “A Survey of Venture Capital Research,” Chapter 8 of Handbook of the Economics of Finance, 2013.

While different studies obtain somewhat different estimates of the net returns, there is an emerging consensus that average returns of VC funds do not exceed market returns. Moreover, there is considerable dispersion and skew. While the net returns of the best VC funds are clearly very high, the median VC fund rarely beats the market, and the lower tail of the distribution can generate large negative returns. What is even more concerning is that these estimates of returns do not account for systematic risk and lack of liquidity.

Degeorge, Martin & Phalippou [2013]: Francois Degeorge, Jens Martin, and Ludovic Phalippou, “Is the Rise of Secondary Buyouts Good News for Investors?,” September 2013.

Private equity firms increasingly sell their portfolio companies to other private equity firms. We show that these “secondary buyouts” are costly for institutional investors, both because the induced transaction costs are large and because secondary buyouts significantly underperform primary buyouts.

Fan, Fleming & Warren [2013]: Frank Jian Fan, Grant Fleming, and Geoffrey J. Warren, “The Alpha, Beta, and Consistency of Private Equity Reported Returns,” Journal of Private Equity 16(4):21-30, Fall 2013.

Over the full sample period, private equity returns display three factors: market beta of less than one, small transaction size and growth, and a four-quarter lag behind public markets. Buyout funds delivered alpha of about 5.5% per annum; venture capital performed poorly. Closer examination reveals that these estimates are inconsistent over time, cautioning against extrapolation from historical averages.

Fang, Ivashina & Lerner [2013]: Lily Fang, Victoria Ivashina, and Josh Lerner, “The Disintermediation of Financial Markets: Direct Investing in Private Equity,” August 2013.

We find that solo investments by institutions outperform co-investments and a wide range of benchmarks for traditional private equity partnership investments. The outperformance is driven by deals where informational problems are not too severe, such as more proximate transactions to the investor and later-stage deals, and by an ability to avoid the deleterious effects on returns often seen in periods with large inflows into the private equity market. The poor performance of co-investments, on the other hand, appears to result from fund managers’ selective offering of large deals to institutions for co-investing.

Jenkinson, Sousa & Stucke [2013]: Tim Jenkinson, Miguel Sousa, and Rϋdiger Stucke, “How Fair are the Valuations of Private Equity Funds?,” February 2013.

During fundraising periods the valuations tend to be inflated compared to other periods in the life of the fund. This has large effects on reported interim performance measures that appear in fundraising documents. We find a distinctive pattern of abnormal valuations which matches quite closely the period up to the first close of the follow on fund. It is hard to rationalize the pattern we observe except as a positive bias in valuation during fundraising.

We find that the performance figures reported by funds during fundraising have little power to predict ultimate returns. … In sum, these results suggest that investors should put little, or no, weight on the IRRs that they read in marketing documents when deciding whether to invest in a follow-on fund. … Perhaps all private equity fundraising documents should contain the caveat ‘interim performance is no guarantee of final performance.’

Kaserer & Stucke [2013]: Christoph Kaserer and Rϋdiger Stucke, “Performance of Private Equity,” chapter 16 in H. Kent Baker and Greg Filbeck, eds., Alternative Investments: Instruments, Performance, Benchmarks, and Strategies, 2013.

Comparing private equity funds on a risk-adjusted basis is still an unresolved issue. Despite all these problems, a vast literature on private equity performance measurement has evolved over the last 10 years. Interestingly, no clear results emerge from this literature with respect to the performance of private equity vis-à-vis other asset classes. Part of this problem is the fact that some of the earlier influential studies used partly incorrect data.

Phalippou [2013]: Ludovic Phalippou, “Yale’s Endowment Returns: Case Study in GIPS Interpretation Difficulties,” Journal of Alternative Investments 15(4):97-103, Spring 2013.

For nonpublic companies, the Global Investment Performance Standard recommends using a since-inception IRR to report performance. This article shows that such a figure can be misleading. The return of the Yale Endowment in private equity is taken as a case study. It is shown that an investor with a long and “average” track record in venture capital computing its return following the GIPS recommendations would display at 30% return over a long horizon and that this number would hardly change in any year from 2000 to 2010, which is similar to what is shown in the annual reports of Yale Endowment.

2012

Ang & Sorensen [2012]: Andrew Ang and Morten Sorensen, “Risks, Returns, and Optimal Holdings of Private Equity: A Survey of Existing Approaches,” Quarterly Journal of Finance 2(3), September 2012.

Studies using company-level data that account for selection bias find high alphas for private equity investments only during the late 1990s, but negative alphas post-2000. The positive alpha estimates are hard to interpret in terms of arithmetic returns, however, because of the very high volatility. Estimates of betas vary substantially, ranging as high as 3.6 for venture capital investments; generally, however, private equity betas are well above one.

Franzoni, Nowak & Phalippou [2012]: Francesco Franzoni, Eric Nowak, and Ludovic Phalippou, “Private Equity Performance and Liquidity Risk,” Journal of Finance 67(6): 2341–2373, December 2012.

Once the risk premia on the book-to-market factor and the size factor are taken into account, the alpha drops to about 3.1%, which is still economically (although not statistically) significant. In the model with liquidity risk, the premia on the four factors entirely account for average private equity returns. The alpha is virtually zero, both economically and statistically, while the risk premium and the cost of capital are about 18% and 24% per year, respectively.

Our main conjecture is that the relation between market liquidity and private equity returns is a reflection of the effect of funding liquidity on private equity performance. … This indicates that funding liquidity is an important source of liquidity risk in private equity.

Our results provide practitioners with a hurdle rate to evaluate private equity. Using such a benchmark, they can assess the NPV of their track record. The cost of capital of about 18% in excess of the risk-free rate that we estimate is in sharp contrast to the widely used hurdle rate of 8%. In addition, our results may call current compensation practices into question. Fund managers and, oftentimes, the private equity team within the investor’s organization receive performance-based compensation if they achieve returns above 8% per annum, but this hurdle rate seems low in view of our findings. Knowing the risk profile of private equity investments is also an important point for portfolio risk management. At times of liquidity crisis, these investments may not offer the risk diversification that investors expect from them.

Harris, Jenkinson & Stucke [2012]: Robert Harris, Tim Jenkinson, and Rϋdiger Stucke, “Are Too Many Private Equity Funds Top Quartile?,” Journal of Applied Corporate Finance 24(4):77-89, Fall 2012.

The state of affairs in private equity benchmarking leaves much to be desired. … As better data become available, there will be large opportunity to tackle the inherent difficulties in assessing returns to illiquid assets such as investments in private equity. Measures such as public market equivalents offer a number of advantages compared to traditional IRRs and money multiplies, but require detailed cash flow data to be calculated properly. … Even if private equity produces a return above that on public markets, is that gap sufficient to compensate for the risk and illiquidity?

Higson & Stucke [2012]: Chris Higson and Rϋdiger Stucke, “The Performance of Private Equity,” March 2012.

For almost all vintage years since 1980, U.S. buyout funds have significantly outperformed the S&P 500. Liquidated funds from 1980 to 2000 have delivered excess returns of about 450 basis points per year. … The cross-sectional variation is considerable with just over 60% of all funds doing better than the S&P, and excess returns being driven by top-decile rather than top-quartile funds. … However, we find a significant downward trend in absolute returns over all 29 vintage years.

These results need extending in several ways. Perhaps the biggest question is the outturn of the funds raised since the mid-2000s in the lead up to the recession. A reliable judgment on this needs data that will take years to emerge. The more pressing issue is the question of benchmark. Since the principal focus of this paper was the measurement of returns, we adopted the S&P 500 as a benchmark, consistent with the existing literature. But hard conclusions about whether or not the U.S. buyout industry has created alpha for its investors requires further research on the appropriate benchmark. Finally, appropriate adjustments for risk will be necessary to draw a definitive conclusion on the risk-adjusted performance of U.S. buyout funds.

Mozes & Fiore [2012]: Haim A. Mozes and Andrew Fiore, “Private Equity Performance: Better Than Commonly Believed,” Journal of Private Equity 15(3):19-32, Summer 2012.

The primary results indicate that (1) buyout funds have better standalone long-term risk-return characteristics than public equity markets and they perform counter-cyclically to public equity markets; (2) when venture funds are combined with buyouts funds, the resulting mix provides a more attractive alternative to public equity markets than buyout funds along provide; and (3) venture funds’ higher absolute returns as compared to buyout funds and public equity markets are restricted to a few vintages and a small number of big winners in those vintages.

Mulcahy, Weeks & Bradley [2012]: Diane Mulcahy, Bill Weeks, and Harold S. Bradley, “’We Have Met the Enemy…and He is Us’: Lessons from Twenty Years of the Kauffman Foundation’s Investments in Venture Capital Funds and the Triumph of Hope over Experience,” May 2012.

Venture capital has delivered poor returns for more than a decade. VC returns haven’t significantly outperformed the public market since the late 1990s, and, since 1997, less cash has been returned to investors than has been invested in VC. … Limited Partners—foundations, endowments, and state pension funds—invest too much capital in underperforming venture capital funds on frequently mis-aligned terms.

Our research suggests that investors like us succumb time and again to narrative fallacies, a well-studied behavioral finance bias. We found in our own portfolio that:

Only twenty of 100 venture funds generated returns that beat a public-market equivalent by more than 3 percent annually, and half of those began investing prior to 1995.

The majority of funds—sixty-two out of 100—failed to exceed returns available from the public markets, after fees and carry were paid.

There is not consistent evidence of a J-curve in venture investing since 1997; the typical Kauffman Foundation venture fund reported peak internal rates of return (IRRs) and investment multiples early in a fund’s life (while still in the typical sixty-month investment period), followed by serial fundraising in month twenty-seven.

Only four of thirty venture capital funds with committed capital of more than $400 million delivered returns better than those available from a publicly traded small cap common stock index.

Of eighty-eight venture funds in our sample, sixty-six failed to deliver expected venture rates of return in the first twenty-seven months (prior to serial fundraises). The cumulative effect of fees, carry, and the uneven nature of venture investing ultimately left us with sixty-nine funds (78 percent) that did not achieve returns sufficient to reward us for patient, expensive, long-term investing.

Phalippou [2012]: Ludovic Phalippou, “A Comment on Recent Evidence on Private Equity Performance,” March 2012.

Claims are regularly made that private equity funds in aggregate generate significant alpha for their investors. Recent findings have been presented as supporting such a claim. … This paper considers recent estimates derived by Robinson & Sensoy [2011], Harris, Jenkinson & Kaplan [2013] and Higson & Stucke [2012]. With access to up-to-date and high-quality data, these studies show an outperformance of the S&P 500 index by buyout funds. Although neither study shows the yearly size-weighted outperformance, their numbers indicate that it is around 3% per annum. However, this note raises several issues that still need to be addressed before concluding that private equity generated a positive alpha. The main issue is probably the existence of a strong size effect in recent years: the S&P 500 index significantly underperformed small cap and mid cap stocks, which are the size categories in which private equity funds mainly invest. Adjusting for size, each of the three studies show private equity returns that are virtually identical to those of public stocks. This means that recent evidence seems to confirm rather than infirm the implications derived by previous research effort.

Robinson & Sensoy [2012]: David T. Robinson and Berk A. Sensoy, “Do Private Equity Managers Earn their Fees? Compensation, Ownership, and Cash Flow Performance,” March 2012.

During fundraising booms, percentage management fees increase and GPs’ compensation shifts toward the fixed component, consistent with greater GP bargaining power and a preference for fixed compensation. Moreover, GPs who receive fees on invested capital tend to exit investments (and thus lower their fee basis) more slowly, while GPs tend to accelerate the pace of exit immediately after they become eligible to receive carried interest. These findings indeed suggest that the fundamental information asymmetry between GPs and LPs allows GPs to game the contractual provisions that are partially in place to protect the LPs’ return, and they certainly illustrate that GPs earn more in boom periods. However, we find no evidence that high-fee funds underperform on a net-of-fee basis.

Wang [2012]: Yingdi Wang, “Secondary Buyouts: Why Buy and at What Price?,” Journal of Corporate Finance 18(5):1306-1325, December 2012.

Overall, the results are consistent with the notion that secondary buyouts serve no purpose aside from alleviating the financial needs of private equity firms.

2011

Metrick & Yasuda [2011]: Andrew Metrick and Ayako Yasuda, “Venture Capital and Other Private Equity: A Survey,” European Financial Management 17(4):619-654, 2011.

The evidence on whether VC and BO funds achieve excess performance is mixed.

Phalippou [2011]: Ludovic Phalippou, “Why is the Evidence on Private Equity Performance so Confusing?,” September 2011.

Selecting a sub-sample such as liquidated funds may create a bias because better funds tend to liquidate more quickly.

It is important to stress that the methodological choices made to compute industry benchmarks are reasonable and understandable at first sight. In NAVs were unbiased estimates of market values, than an end-to-end approach would often lead to the right answer. Even the use of IRR would be reasonable if there are no large early capital distributions. The point of this article is to show that the industry methodology can generate significant biases, misleading figures and unstable numbers.

Robinson & Sensoy [2011a]: David T. Robinson and Berk A. Sensoy, “Cyclicality, Performance Measurement, and Cash Flow Liquidity in Private Equity,” November 2011.

Liquidated buyout funds have an average TVPI of 1.57, an average PME of 1.18, and an average tailored PME of 1.10. For venture funds, the progression is from 1.44 to 1.03 to 1.06. Medians display similar patterns.

Overall, our results on fund size and performance are consistent with Kaplan and Schoar [2005]. If anything, they suggest that the poor relative performance of very large funds they document has only worsened since their sample period.

Robinson & Sensoy [2011b]: David T. Robinson and Berk A. Sensoy, “Private Equity in the 21 st Century: Cash Flows, Performance, and Contract Terms from 1984-2010,” February 2011.

On average, our sample funds have outperformed the S&P 500 on a net-of-fee basis by about 15%, or about 1.5% per year. Performance and cash flows over time are highly correlated with public market conditions.

Stucke [2011]: Rϋdiger Stucke, “Updating History,” December 2011.

Previous studies that use Thomson VentureXpert’s fund performance data and statistics (particularly Kaplan & Schoar [2005] and Phalippou & Gotttschalg [2009]) are inevitably impacted by…a significant downward bias of the private equity benchmark. Using TVE’s data for the sub-sample of ‘officially liquidated’ funds, I find substantial outperformance of U.S. buyout funds relative to the S&P 500, especially for vintage years prior to 1986.

2010

Cumming & Walz [2010]: Douglas Cumming and Uwe Walz, “Private Equity Returns and Disclosure Around the World,” Journal of International Business Studies 41(4):727–754, May 2010.

Private equity funds may overstate the value of their investments in order to attract new investors into follow-up funds. … Using evidence from 39 countries, we show that there are significant systematic biases in managers’ reporting of fund performance. We find that these biases depend on the accounting and legal environment in a country, and on proxies for the degree of information asymmetry between institutional investors and private equity fund managers.

Harris, Jenkinson & Stucke [2010]: Robert Harris, Tim Jenkinson, and Rϋdiger Stucke, “A White Paper on Private Equity Data and Research,” December 2010.

Overall, the recent research suggests that private equity’s attractiveness is likely overstated by looking at reported returns. The level of returns is subject to debate and risk measures are often understated.

Metrick & Yasuda [2010]: Andrew Metrick and Ayako Yasuda, “The Economics of Private Equity Funds,” Review of Financial Studies 23(6):2303-2341, 2010.

Among our sample of funds, about two-thirds of expected revenue comes from fixed-revenue components that are not sensitive to performance.

Phalippou [2010]: Ludovic Phalippou, “Private Equity Funds’ Performance, Risk and Selection,” July 2010.

We review the literature on the risks and returns of private equity funds, comparing the different datasets used in academic research. Irrespective of the datasets used, average returns seem to be lower than public equity returns and, in any event, less spectacular than often conjectured.

2009

Ang, Goetzmann & Schaefer [2009]: Andrew Ang, William N. Goetzmann, and Stephen M. Schaefer, “Evaluation of Active Management of the Norwegian Government Pension Fund – Global,” December 2009.

There is surprisingly little convincing evidence of superior risk-adjusted returns to private equity and venture capital. Despite claims that top managers can produce consistent high returns, the current data are not conclusive on this point.

Kaplan & Strömberg [2009]: Steven N. Kaplan and Per Strömberg, “Leveraged Buyouts and Private Equity,” Journal of Economic Perspectives 23(1):121-146, Winter 2009.

What will happen to funds and transactions completed in the recent private equity boom of 2005 to mid-2007? It seems plausible that the ultimate returns to private equity funds raised during these years will prove disappointing because firms are unlikely to be able to exit the deals from this period at valuations as high as the private equity firms paid to buy the firms. It is also plausible that some of the transactions undertaken during the boom were less driven by the potential of operating and governance improvements, and more driven by the availability of debt financing, which also implies that the returns on these deals will be disappointing.

Phalippou [2009a]: Ludovic Phalippou, “Beware of Venturing into Private Equity,” Journal of Economic Perspectives 23(1):147-166, Winter 2009.

The average private equity buyout fund charges the equivalent of 7 percent fees per year, despite a return below that of the Standard & Poor’s 500. Why are the payments to private equity funds so large? Why does the marginal investor buy buyout funds? I explore one potential—and probably the most controversial—answer: that is, some investors are fooled. I show that the fee contracts are opaque. The compensation contracts for buyout funds typically imply lower fees at first sight than actually occur. The larger fees are generated by what seem like minor details in these contracts. Investors may thus underestimate the impact of fees. … Finally, to further understand the potential agency conflicts between buyout funds and their investors, I discuss a few features of buyout contracts that exacerbate conflicts of interest, rather than mitigate. For example, several contract clauses provide incentives that can distort the optimal of investments, their leverage, and their size.

Phalippou [2009b]: Ludovic Phalippou, “The Hazards of Using IRR to Measure Performance: The Case of Private Equity,” September 2009.

When raising capital, private equity funds provide track records expressed in terms of IRR and cash multiples exclusively. … In this article, it is shown that IRR is probably the worst performance metric one may use in an investment context. It exaggerates the variation across funds, exaggerates the performance of the best funds, can be readily inflated and provides perverse incentives to fund managers.

Phalippou & Gottschalg [2009]: Ludovic Phalippou and Oliver Gottschalg, “The Performance of Private Equity Funds,” Review of Financial Studies 22(4):1747-1776, April 2009.

The performance of private equity funds as reported by industry associations and previous research is overstated. A large part of performance is driven by inflated accounting valuation of ongoing investments and we find a bias toward better performing funds in the data. We find an average net-of-fees fund performance of 3% per year below that of the S&P 500. Adjusting for risk brings the underperformance to 6% per year. We estimate fees to be 6% per year.

2007

Anson [2007]: Mark J.P. Anson, “Performance Measurement in Private Equity: Another Look,” Journal of Private Equity 10(3):7-22, Summer 2007.

What we label skill by the private equity manager as measured by the alpha intercept in the single period regressions might, in fact, reflect lagged pricing effects instead of real skill. Stale pricing in private equity portfolios can be a problem because the private equity manager has considerable discretion as to when he will mark his portfolio up or down.

When we included lagged public stock market returns in our analysis, we found that the alpha coefficient—a measure of private equity manager skill—eroded significantly. In fact, in many cases, the inclusion of lagged public stock market returns eroded the alpha coefficient to insignificant levels—essentially random noise. Clearly, what had been previously thought to be private equity manager skill was more a function of prior public stock market returns that had not been accounted for when considering a private equity manager’s current performance.

Conroy & Harris [2007]: Robert M. Conroy and Robert S. Harris, “How Good are Private Equity Returns?,” Journal of Applied Corporate Finance 19(3):96-108, Summer 2007.

The bottom line of our analysis is that the average net returns (after management fees) to investors in private equity have not been nearly as attractive on a risk-adjusted basis as many have assumed. Risks are often understated and returns overstated, owing large part to the way in which the assets of private equity firms are periodically valued and disclosed. … The root causes of the overstatement are biases in reported data when assets are not traded. Our results suggest that ‘average’ returns in private equity may not be sufficient to justify the illiquidity and costs associated with adding the asset class to one’s portfolio

Moreover, our analysis fails to take account of some key practical attributes of private equity investing. The ‘time weighted’ returns used to create standard indices for asset classes such as

bonds and public stocks do not mirror some of the dynamics of private equity investing. Funds have finite lives, the general partner decides when to call capital from investors and there are substantial interim cash flows paid out to investors when the fund sells assets. Unlike the case in public markets, investors in private equity may not be able to put their money to work quickly and reinvestment opportunities may be limited.

Driessen, Lin & Phalippou [2007]: Joost Driessen, Tse-Chun Lin, and Ludovic Phalippou, “Estimating the Performance and Risk Exposure of Private Equity Funds: A New Methodology,” Network for Studies on Pensions, Aging and Retirement Discussion Paper 2007-023, August 2007.

Using a dataset comprising 797 mature private equity funds spanning 24 years, we find a high market beta for venture capital funds and a low beta for buyout funds, and report evidence that private equity risk-adjusted returns are surprisingly low. … The CAPM specification gives a beta of 2.18 and a significantly negative alpha of about -15% per year for the VC funds. … When the two Fama-French factors are added, alpha increases to -10% per year because VC funds overall are similar to small growth stocks, which have low performance over this time period. BO funds are found to have a much lower beta of 0.09 and a slightly positive alpha. However, adding SMB and HML increases the beta to 1.04 and also leads to a significantly negative alpha of -9% per year. … We also show that the NAVs reported near the end of the typical fund life are highly upward biased estimates of the market value of funds. Specifically, using a regression approach, we find that the final market values of funds that are 10 to 13 years old are only 28.7% of their self-reported net asset values.

Phalippou [2007]: Ludovic Phalippou, “Investing in Private Equity Funds: A Survey,” April 2007.

The performance of private equity funds is lower than the performance of the S&P 500 by as much as 3.8 percent a year, and the risk properties of the S&P 500 seem more attractive.

2005

Kaplan & Schoar [2005]: Steven N. Kaplan and Antoinette Schoar, “Private Equity Performance: Returns, Persistence, and Capital Flows,” Journal of Finance 60(4):1791-1823, August 2005.

Over the entire sample period (1980-1997), average fund returns net of fees are roughly equal to those of the S&P 500. … We acknowledge, however, that the average return results are potentially biased because we do not control for differences in market risk and because of possible sample selection biases. … Finally, we find some evidence that fund and partnerships that are raised in boom times are less likely to raise follow-on funds, suggesting that these funds perform worse.

Phalippou & Zollo [2005]: Ludovic Phalippou and Maurizio Zollo, “What Drives Private Equity Fund Performance?,” November 2005.

Using a novel and comprehensive database on both US and EU private equity funds and their underlying investments, we study the drivers of private equity fund performance. First, we

study whether their hedging properties are attractive enough to justify their low performance. We document that fund performance co-varies positively with both business cycles and stock-market cycles, an unattractive property. We also find that private equity funds—like hedge funds—are exposed to tail risk.